Installment Sale of a Business: the facts

1. A sale with at least one payment after the year of sale is an installment sale, and the gain is reported as the payments come in unless the seller elects out (§ 453(a), (b)(1), (d)). Each payment of principal carries gain in the proportion the gross profit bears to the contract price (§ 453(c)).
2. Depreciation recapture under §§ 1245 and 1250 does not wait. It is ordinary income in the year of sale whatever the cash received, and it is added to basis so that only the remaining gain is spread (§ 453(i)).
3. Interest on the note is ordinary income as it is paid, on top of the gain in the principal. A note that states too little interest has interest imputed to it (§§ 483, 1274).
4. Example: a business sold for $2,000,000 with a $500,000 basis and $100,000 of recapture, $400,000 down and the rest over 4 years at 6%: 70% of each principal dollar is gain, the year-of-sale tax is $93,000 against $317,000 for a cash sale, and $224,000 is pushed into later years.
5. When the installment obligations arising in a year and still outstanding at its close exceed $5 million, the seller pays interest to the Treasury on the deferred tax (§ 453A(c)), and pledging the note as collateral for a loan is treated as receiving payment (§ 453A(d)).
6. If a related buyer resells within 2 years, the seller is treated as receiving the resale proceeds (§ 453(e)). Inventory cannot be reported on the method (§ 453(b)(2)(B)), and neither can publicly traded stock (§ 453(k)(2)). The seller carries the buyer's credit for the life of the note.

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